Money management in Forex is a topic that a lot of aspiring FX traders tend to avoid, unfortunately. The reality of Forex trading is that it is risky; you can lose all your money and more if you’re not careful. So, since this is a fact, you will need to figure out an effective way to manage your money on every single trade you take so that you give yourself the best chance of succeeding long-term in the markets.
How to Read and Understand Forex Trading Signals? The implementation of the correct approach is essential for the beginners at the platform. There are better chances available for long-term success at the trading platform. Learning about the approaches is essential to get success.
Different Forex money management strategies:
- Percent R model –
The percent risk (R) model says that traders should risk a fixed percentage of their trading account on every trade they take. The theory behind this risk management model is that when a trader hits a losing period they will be trading a smaller position size since their percent risk will now be smaller in dollar terms, thus theoretically helping to limit their losses. When their account increases in value they will risk a larger dollar amount since the fixed percent risk of their account will now be larger.
In theory this model sounds pretty good. However, what many people don’t tell you about the percent R model is this; after a series of losing trades it is going to take you a very long time just to get back to your previous account balance since you will be trading a smaller position size each time you lose. What this means for most traders is a cycle of over-trading, because after a large drawdown they are stuck trading a much smaller position size and it thus takes them a long time to get back to where they were.
Most traders become frustrated once they realize they are trading much smaller position sizes after a series of losers and just end up over-trading to try and “make back” the money they lost. So, essentially, the theory behind trading a lower position size as a percentage of your account after a drawdown doesn’t really hold up if you end up over-trading anyways, and most traders who submit to the percent R model end up over-trading after losing periods.
Also, if you follow the percent R model, after a series of losers if you starting winning again, you will actually be significantly limiting your gains because your percent R is now a much smaller dollar amount than it was before. So, the problem with this forex money management model is that it can subtly induce over-trading and it also limits your winning trades after drawdown periods. On the positive side, if you can actually follow this model, it will work to limit your losses in periods of losing trades, but you must then be OK with trading a much smaller position size when you start winning again, and this can sometimes be quite frustrating and keep you stuck in perpetual cycle of over-trading.
- Dollar R model –
In the dollar risk (R) model, traders risk a set dollar amount on each trade rather than risking a percentage of their account on each trade. This dollar amount depends on your personal risk tolerance as well as your overall financial situation. Most traders who follow the dollar R model will aim to keep their trading account balance near the same level most of the time by withdrawing profits each month.
One of the advantages of the dollar R model is that after a series of losers you are not trading a drastically smaller position size, so when you start winning again it will not take you very long to get your trading account back up to where it was previously. The flip side of this is that you have to be very careful to not over-trade, because you can easily blow out your trading account if you are trading too much and risking a set dollar amount.
Indeed, the fixed dollar R model is for traders who have a firm handle on their trading mindset and discipline. Traders who have truly mastered their forex strategy know exactly what they are looking for in the market, so they never fear losing the money they have at risk because they know they are just executing their pre-defined trading edge. You will first have to learn some effective forex strategies and really master them, then you’ll have to make sure you have enough discipline and fortitude to not over trade, when you reach this point you will want to employ the dollar R forex money management model.